COST ACCOUNTING. A system of accounting designed to show the actual cost of each separate article produced or service rendered from time to time, as distinguished from the ordinary system of accounting which aims only at showing the working results of a business as a whole, or sometimes of each separate department of a business. The two systems of accounting are usually compiled independently of each other by different staffs, but if satisfactory results are to be reached these must work in co-operation, and the results produced must be reconcilable and mutually explanatory.
The origin of cost accounting, like the origin of book-keeping itself, is unknown; but possibly the first attempts in this direction were made in connection with the tin mines of Cornwall, as under the ancient Stannary courts of Cornwall tin mining companies were formed, called cost book companies, a form of organization very similar to the
company still extant in Australia. However that may be, systematic costing was usual in mining concerns long before anyone thought of ex tending it to manufacture generally.
The necessity for cost accounting arose out of the direction in which ordinary accounting methods de veloped to meet the growing requirements of modern business. In mediaeval times trade consisted mainly of a series of separate ventures, or voyages, for each of which a separate account was kept, so that at the end the actual result of that particular ven ture or voyage was shown by the account. When commerce as sumed the form of continuous trading, however, the method adopted was to merge everything into a single trading account which showed the results of the trading as a whole, but no details. In the nature of things, such a method of accounting could only be satisfactory so long as it was reasonable to assume that all the business undertaken contributed pro rata to the final result. In some cases (e.g., in many department stores and wholesale warehouses) this assumption may be sufficiently near the truth f or practical purposes, but it is never even approximately true in a manufacturing concern. Indeed, it seems safe to say that in al most every business some lines are more profitable than others, and that (whether it be recognized or not) some lines are quite unprofitable. Hence the need for a system of accounting that will give detailed information as to the exact cost of each separate thing sold, or each service rendered, especially in cases where the selling price has of necessity to be determined in advance.
Because cost accounting is in the main a search for detailed information, it follows that the most con venient and suitable methods will be found to vary in almost each individual case. Accordingly, only the barest outline of a system of cost accounting can be indicated here. The first step is to determine the number of separate cost accounts that are to be kept. In some businesses where production is continuous, these individual cost accounts would also be continuous and balanced periodically like trading accounts, but in the case of contract work the number of accounts will vary from time to time accord ing to the number of contracts then in progress. Each separate cost account may be (and often is) sub-divided, so as to show the work performed by each separate department thereon. The other broad basis of division is to separate the outlays chargeable against each separate cost account (or sub-account) into (a) labour, (b) materials, (c) overhead. Each of these will again be subject to sub-division.
Labour represents the cost of work done directly for, and in connection with, any particular cost account. It is not, therefore, quite the same thing as wages paid ; as lost time, time occupied upon spoilt work, idle time, and cost of supervision are not directly chargeable against any particular piece of work, and have therefore to be transferred to overhead charges. (Loss arising from spoilt work should be treated as part of the overhead charges of the department where the "spoil" occurs.) Everything that has been paid away has to be charged up somewhere, and an agreement of totals is an essential part of a satisfactory costing system. If suitable office machinery be employed it is quite practicable to effect this agreement before the wages are paid, and therefore in time to prevent any over payment of wages.
Costs.—Materials represents the cost of all materials directly used in connection with work for which any cost account is opened. Some of these materials will be purchased specially for a particular job and can therefore be charged direct to that job, -others will be issued from store; but the total value of materials charged against cost must agree with the total value credited to suppliers of direct purchases and to the stores department. In connection with the stores records a great deal of detailed work is necessarily involved, and here again office machinery is es sential in a concern of any magnitude. In order to reach really satisfactory results, stores records should be kept in both quanti ties and money values, otherwise no effective check on quantities is available. The same exact agreement of totals that was prac ticable as regards wages is not practicable as regards stores, partly because of discrepancies in weight, etc., owing to inevitable waste or alterations in atmospheric conditions ; partly because when materials have been in store for a considerable time it does not at all follow that their original cost is a fair price at which to charge them out against current jobs. Such discrepancies, as well as the general expenses of the stores department, are usually in cluded in the overhead, but they need careful watching. Labour and materials together constitute prime cost.
Costs.—Overhead consists of every kind of work ing cost not comprised in one or other of the previous headings. According to the nature of the business it may be anything be tween (say) 5% and 8o% of the total cost, but in any event it represents outlays which by their nature cannot be regarded as directly chargeable against any particular item of output. The total must therefore be spread over the whole output as equitably as possible, according to some preconceived formula. Herein lies the weakness of many costing systems. Formerly, overhead used to be dealt with by adding a pre-arranged percentage to prime cost. This of course assumes that the actual use made by the dif ferent jobs of the services comprised under "overhead" is, in fact, in proportion to their respective prime costs. In fact, it is quite as often in an inverse ratio. No treatment of overhead can ever be satisfactory that does not aim at sub-dividing the overhead as a whole into the overhead of each separate department; the burden of the overhead expenses of each department may then be distrib uted over the output of that department week by week, or month by month, with some approach to fairness. But even then, the method of distribution should be elastic rather than rigid; that is to say, week by week, or month by month, someone in authority with a knowledge of the facts should approve the proposed dis tribution before it is given effect to. It is moreover important to see that the total amount distributed is reconcilable with the total amount of expenses incurred ; otherwise, the aggregate costing results at the end of the year cannot agree with the results shown by the profit and loss account.
Absolute agreement is impracticable, but a reconciliation of the two totals is at least essential. Absolute agreement may be im practicable because, in order to arrive at the true cost, it may be necessary to include items which have not in fact had to be paid away. For instance, the fact that a manufacturer owns the free hold of his works is no reason why a fair charge for the rent of those works should not be included as part of his working costs; the fact that a manufacturer is paying interest on borrowed money because he is working with insufficient capital is no reason for saying that his operative costs are therefore higher ; the fact that a manufacturer has for prudential reasons written down his plant and machinery far below their true value is no reason why a proper figure, representing the actual depreciation for the current period, should not be charged against the current output. Simi larly, such items as bad debts, interest on investments, etc., while necessarily coming into the profit and loss account, have no bear ing upon the practical working of the business, and are therefore quite properly omitted from the costing records.
To sum up, it may be said that a satisfactory system of cost accounting assists the management to reduce working costs by pointing out waste and avoidable delay; to select its output wisely, and to vary the quantity of output as circumstances may require; to choose wisely between alternative methods of operation or production; to check quotations, by com paring estimates of cost made in advance with actual costs as sub sequently ascertained. Cost accounting also provides the only reliable means of estimating the value of work in progress; of determining the extent to which sub-contracting is desirable ; of deciding when to buy and when to manufacture where each alter native is possible. In addition, a proper system of cost accounts provides an effective check upon the stores department, and upon each operative department. It is the best possible safeguard against wages frauds or leakages of any kind, because every outlay has to be charged up to some cost account, and every cost account is being closely watched by interested parties who may be relied upon to challenge any but the most trifling overcharges. Every cost account (or sub-account) represents the results achieved by someone, be he works manager or foreman, or someone inter mediate, who may be relied upon to see that his results are not belittled by improper charges. If manufacturers were to pool their results, a comparison of the working costs of similar undertakings would undoubtedly be generally beneficial ; but, outside of public service undertakings, such comparisons are not at present avail able.
the nature of things the most useful books on Bibliography.--In the nature of things the most useful books on cost accounting deal with its application to one particular set of circumstances, and are of but little use elsewhere. The chief books dealing with general principles are: Dicksee, The Fundamentals of Manufacturing Costs (1917) ; Dicksee, Book-keeping for Accountant Students (192I) ; Dicksee, Advanced Accounting (1921) ; Cathles, The Principles of Costing (1924) ; Hawkins, Cost Accounts (1927) ; A. H. Church, Manufacturing Costs and Accounts (i917) ; E. M. Taylor, The Principles of Cost Accounting (1936) . (L. R. D.) Some features of Cost Accounting which have been developing rather rapidly in the United States are : (I) retail cost accounting; (2) bank cost accounting; (3) sales cost accounting; (4) uniform cost accounting; and (5) standard costs.
This is a term applied particularly in department stores where probably the most important problem of management is that of determining the profitableness of each of the departments. The department store being similar to a collection of individual stores, it is particularly essential that each be conducted so as to return a profit on the capital invested in it. The problem of cost accounting in this connection is essen tially that of the distribution of overhead expenses. The merchan dise accounts, sales and purchases are segregated by departments in order to give the proper control over merchandising activities. Similarly the salaries of assistants whose time is employed fully by a given department are without difficulty segregated as charges against that department. Practically no other costs can be charged directly to a department because they are for the most part shared jointly by several; e.g., the general expenses of the buying department are incurred for the benefit of the entire store, stock clerks may serve several departments, all of the general housing expenses—light, heat, janitor service, repairs, rent, etc.—are for the benefit of all departments, as are the stores' delivery service costs and the newspaper advertising and other publicity expenses, which include the operating expenses of the advertising depart ment ; as well as the general administrative expense covering the management of the store as a whole. If accurate profit results are to be computed for each department, all of these expenses must be prorated on some equitable basis over the departments receiving the benefit of the service. Some of the bases adopted for the distribution of these expenses are as follows: buying expenses are prorated on the basis of the net purchases in each department ; the space advertising on the basis of space used by each department ; general advertising, general selling expenses, and general administrative expense of the whole organization on the basis of the sales of each department ; delivery expense on the percentage of packages delivered for each department ; rent, main tenance and operation on the basis of floor area occupied by each. In this way the net profit operating results of each department are determined on very much the same basis as would be the case were each an independent unit.
The banks have long recognized that the services rendered customers growing out of the bank's deposit function are quite costly to the bank and are of real value to customers. Only recently has any attempt been made to evaluate the cost of these services as compared with the value of the customer's deposit to the bank. In attacking the problem the bank has been desirous of determining the minimum balance which it should require each depositor to maintain, in order to cover the cost of the bank's services rendered to that depositor. The problem is a particularly complicated one because of the difference in activity of the various depositors' accounts, some depositors drawing many cheques during the month, others only a few. The more active accounts, requiring the handling of more cheques naturally are more expensive to the bank than the inactive. Similarly, from the deposit standpoint, the customer who makes many deposits in his account, many being cheques which his own bank will have to collect, receives more service from the bank than the one who is relatively inactive in this regard. No entirely satisfactory solution of this cost accounting problem in the bank has yet been reached. Working methods are, however, being employed by a great many banks to the extent, at any rate, that most have adopted a minimum balance which must be maintained by all depositors in order to entitle them to free service, those customers whose balances fall below this being charged a service fee.
As distribution costs increase, manu facturers and wholesalers give them an increasing amount of attention, the problem being investigated along two main lines. In the first place an attempt is being made to discover an equitable basis for pro-rating over the product the general selling expenses, which is essentially the same problem as the distribution of over head expenses in the factory. In order to determine the full cost of placing the product in the hands of the customer it is necessary to distribute on an equitable basis the selling expense incurred. Sales salaries, travelling expense, entertainment, advertising, both national and local, delivery expenses, general head office selling expense, including the salaries of sales manager and his staff, clerical expenses and supplies--all of these things must be dis tributed over the various products sold before it is known which are profitable and which are not. An investigation of this kind will have a direct bearing on the sales policies of the company as indicating the products the sale of which should be pushed and those which should be entirely cut off, or be carried merely as a convenience to customers with a recognition of what such a policy costs. The second line of investigation, viz., the determina tion of which customers are profitable, is closely related to this. It has been found, for example, in a given manufacturing concern that 9o% of its total sale volume was sold to io% of the total customers at a cost of 5% of its total selling expense. This means that io% of its total sales volume was sold to 9o% of its custom ers and that the cost of increasing its sales volume by this
was 95% of its entire selling expense. Certainly had no effort been made to sell to these customers-9o% of the total number—the net profit of the company would have been much larger. An investigation of this kind requires a very careful alloca tion of selling expenses on the basis of the business done with each customer rather than on the basis of the unit or kind of products sold, although a knowledge of the manufacturing and selling cost of each may be necessary in determining the profitable ness of the business done with each customer. Investigations of this kind are very enlightening and absolutely necessary, in order to give a factual basis for the formulation of intelligent sales policies.
Reference is made under BALANCE SHEET to a trend toward the development of uniform systems of accounting in trade association work. Particularly in those trades where competition is keen and net profit results from the point of view of the marginal unit of business are apt to be unsatisfactory, it is essential for a business man to know his costs. The trade association has recognized this and has tried to bring sharply to the attention of all of its members the absolute necessity of a system of accounts which will give him the neces sary information to determine a selling price adequate to cover all costs and leave a margin of profit. Many trade associations have secured the co-operation of a large proportion of their mem bers in reporting their business costs under the uniform account ing titles adopted by the association ; these have been handled confidentially and from them averages have been built up some times for the trade as a whole and frequently also in classified groups by businesses, localities, etc. These averages have pro vided norms or standards by comparison with which the individual merchant or manufacturer is able to judge his relative efficiency. Some of these uniform systems of accounting have been developed through accounting committees within the organization itself, while in other cases the professional services of public accountants have been utilized.
The standard costs system, also known as predetermined or budget costs, is one of the most recent move ments in cost accounting; its chief point is estimating the cost of the product before it is produced. This estimate is frequently made by the engineering department, and consists of estimates of the cost of materials to be used, of the direct labour involved, and of the overhead expenses. For proper efficiency these esti mates should be made in very great detail, in accordance with the plan or process of manufacture of the product. The costs of actual manufacture are then gathered by the accounting system under the same titles as were used in the making of the estimate; these are compared with the estimated or standard costs and the variations, or variances, as they are usually called, are noted and the attention of the responsible executive is given particularly to those items where these are greatest. In this way, so long as the costs of manufacture fall within the limits set by the estimated manufacturing standards, the results are considered satisfactory and no special attention from executives will be required, and hence they can devote their undivided attention to conditions shown to be unsatisfactory. As yet there is no uniform account ing technique for this method, but its basic idea has gained rather wide acceptance owing to its great value from the standpoint of management.
The National Association of Cost Accountants, which operates through some 3o or more chapters in manufacturing centres of the United States, is the leading professional society in this field.
See also SCIENTIFIC MANAGEMENT.
L. Dohr, Cost Accounting (1924) ; W. B. LawBibliography.-j. L. Dohr, Cost Accounting (1924) ; W. B. Law- rence, Cost Accounting (1925) ; J. Lee Nicholson and J. F. D. Rohr bach, Cost Accounting 0919) ; J. P. Jordan and G. L. Harris, Cost Accounting (1925) ; F. E. Webner, Factory Costs 09'0 ; P. M. Atkin son, Textbook of Industrial Cost Accounting (1924) ; J. R. Hilgert, Sales Cost Accounting (1926) ; G. C. Harrison and J. J. Bock, Stand ard Cost Accounting (1928) ; A. C. Hodge, Retail Accounting and Control (1925); F. L. Beach, Bank System and Accounting (1928).
(R. B. K.)